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Can Gold Bulls Keep It Going After Japan's Big QE And A Weak Jobs Report?

Gold prices have fallen consistently since last October, just before the impressive rally in equities took off. Yet the yellow metal found some strength toward the end of last week, rallying on the Bank of Japan’s impressive expansion to its program of quantitative easing, finding further support from the worst jobs report in nine months fueling continued easing expectations in the U.S. The flare up of the European sovereign debt crisis, with Cyprus still in trouble, Italian political uncertainty, and now problems returning to Portugal, could push the European Central Bank to loosen monetary conditions further, possibly setting the stage for gold to move higher.

While commodities are generally quite responsive to macro events, gold has been particularly targeted by investors in times of intense stress and high uncertainty. Gold has also been very responsive to the size of major central banks’ balance sheets, with bullion prices benefitting from easing across the globe.

Over the past few trading sessions, the yellow metal seems to have decoupled from the commodity complex, first jumping in response to freshly-minted BoJ governor Haruhiko Kuroda’s intention to expand Japan’s monetary base by about 10% of GDP. “[Last] Thursday morning, Bank of Japan (BoJ) released their aggressive announcement showing how serious they are about reaching their 2% inflation target and the gold market listened,” explained Sara Yates, global currency strategy at JPMorgan Chase’s private bank. With Japan “doubling [its] monetary base by the end of 2014, the gold market has room to catch up,” Yates added.

Indeed physical gold found a floor on Thursday below $1,542 an ounce, only to rally more than 2.6% to close the week at $1,581.80. The yellow metal had been trading in tandem with the broader commodity complex this year, as a comparison between the SPDR Gold Shares ETF (GLD) and the PowerShares DB Commodity Index shows. Yet gold broken out last week, rising on Thursday and rallying on Friday, as the March jobs report disappointed markets.

“Gold and silver prices rose from multi-month lows as US payrolls surprised to the downside, strengthening the case for on-going Federal Reserve stimulus to support the economic recovery,” wrote Martin Arnold and Nicholas Brooks of ETF Securities in a note on Monday. They attributed the dramatic move, bullion gained nearly $30 per ounce on Friday, to the substantial build-up in gold shorts:

CFTC data showed a 17,273 decline in net longs in the week to last Tuesday, mainly on the back of a build-up of short positions. It is likely the reversal of those elevated short positions served as a catalyst for positive price movement when the weak US job data was released and the BoJ announced that it will double its monetary base within two years.

The third factor that has been supportive of gold over the past few trading sessions has been the ECB’s expected reaction to a new leg of the never-ending financial crisis in Europe. “At last week’s ECB meeting, Draghi signaled the ECB had an easing bias,” said JPMorgan’s Yates. Draghi has three major options to ease the ECB’s policy stance including cutting the refi rate, the deposit rate, and/or engaging in unconventional measures such as a new LTRO liquidity injection.

ECB chief Mario Draghiinsisted last week in his press conference that the Eurozone’s economic outlook “remains subject to downside risks.” He reiterated the ECB’s “determination to maintain the euro,” indicating to markets a cut could be in the cards in the near term. With the Cyprus bailout “fresh in investor minds,” political uncertainty in Italy running high, and now concerns over Portugal’s fiscal situation (after a Constitutional Court blocked Lisbon’s plan to suspend certain payments to state workers and pensioners), the ECB may be more inclined to cut rates sooner rather than later.

These three factors (Japanese QE, weak labor markets in the U.S. supporting Bernanke’s loose policies, and a return of the European sovereign debt crisis), suggest gold prices could find support going forward. Gold bulls will continue to face pressure from an improving U.S. economy, and a subsequent strengthening of the U.S. dollar, and European policymakers’ ability to put out a fire.

Gold hasn’t held up well in 2013, having shed about 6% year-to-date. Bullion has performed substantially better than gold equities, with major miners like GoldCorp, Newmont Mines, and Barrick Gold down between 15% and 24%.

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